Editorial: Letting AIG flounder may be only choice

March 4, 2009

Moral hazard is the term economists use to describe a policy or action that either rewards irresponsible behavior or prevents the irresponsible party from being punished in the ordinary course of things.

It is especially relevant when considering AIG (American International Group), the insurance behemoth that is reportedly getting access to another $30 billion of the taxpayers’ money (well, it might be money borrowed from China just now and payable by the taxpayers either in the form of future taxes or inflation).

AIG has already received some $150 billion from the government — a $60 billion loan last fall when bailout mania was just beginning, followed by $40 billion to purchase preferred shares of the company stock (down to 42 cents on Monday) and $50 billion to soak up some of the company’s “toxic assets.”

Despite — or because of? — all that government help, AIG managed to post a $62 billion loss in the fourth quarter of last year, the largest corporate loss in corporate history.

A case can be made the previous bailouts had something to do with AIG’s poor performance. Samuel Johnson once said “Nothing focuses the mind like a hanging.” In the corporate world, nothing focuses the mind like the prospect of bankruptcy or having to go out of business altogether.

When a company has already gotten more than $100 billion from the government, it can have a certain expectation that it will receive more backing if recovery is delayed a bit or if things don’t go especially well. Once the government has “invested” in a private company it has a vested interest in “investing” more to make sure it doesn’t go under entirely. So it might be understandable if corporate managers act as if things are not quite so urgent, that they have a little breathing room.

The argument is that AIG has investments and insurance instruments in so many industries and companies, not just nationally but globally, that its failure would start such a cascade of panic as to present a systemic risk to the entire global economic machine. It is “too big to fail.”

If the only thing propping up the global financial system, however, is a company that lost $60 billion last quarter, then the global financial system is a house of cards rooted in self-deception. As the previous failure to prop up AIG and other financial institutions should have demonstrated by now, if a company or institution is deemed “too big to fail” by financial gurus and political pundits, it is probably too big to exist in the first place. It is certainly too risky a proposition for unelected bureaucrats to be placing bets on with the taxpayers’ money.

The “unregulated” marketplace so many are eager to blame for the current financial crisis imposes serious discipline on those who make mistakes or misjudge what consumers really want — the risk of going out of business. That is a much more effective rein on irresponsible or rash behavior than a government agency filled with wet-behind-the-ears young regulators fresh from their M.A.’s in public policy.

Government bailouts seek to countermand this effective discipline of the marketplace, but they cannot make an unsound company sound — they can only try to conceal the fact.